Pressure is mounting on central banks in the Gulf to fight surging inflation when they meet on Wednesday by severing the link between their currencies and the tumbling US dollar.

Officials in Qatar and the United Arab Emirates have denied rumours of an imminent decoupling, but investors are betting on reform and are rushing to buy local currencies as investment banks issue fresh calls for revaluation.

Analysts said that, despite the momentum, the Gulf states were unlikely to decouple suddenly from the dollar. They predicted more measured moves towards links to a basket of currencies.

The feeling is [that] unilateral moves would only cause more confusion and difficulties for those countries who try to maintain the peg, Jason Goff, head of group treasury and market sales at Emirates Bank, said. Mr Goff said that the Gulf states were more likely to move towards establishing a monetary union before they dropped the dollar. I'm not holding my breath for a de-peg any time soon, he said.

However, in a region where inflation has sent everything from the cost of food to construction supplies soaring, frustration is growing. In Qatar, inflation reached 12 per cent last year, the highest in the region, according to the International Monetary Fund. The UAE's inflation was 8 per cent. Some estimate that off-book inflation is as high as 40 per cent for some goods.

With central banks unable to lower interest rates to tackle inflation, the Gulf states are trying other measures. Qatar has frozen rents for two years and the UAE has announced price controls on basic foods and said that it would cancel customs levies on cement and steel imports.

Yet there is a consensus emerging that something more drastic needs to be done to achieve lower inflationary targets, such as the 5 per cent goal that the UAE announced last week.

A revaluation is certainly required to ease inflationary pressures, Zahed Chowdhury, head of Middle East research in Dubai for Deutsche Bank, said. The bank predicts that Qatar and the UAE will ditch their dollar pegs this year and track currency baskets, as Kuwait did last May. The currency peg with the dollar worked well while both economies were moving in the same direction. Now, these two economic blocks are moving in completely opposite directions and it no longer makes sense, Mr Chowdhury said.

Faced with rising construction and labour costs, Gulf corporations are leading the call for currency reform.

Business leaders complain of a looming labour shortage as companies struggle to lure foreign workers, and say that shortfalls of increasingly expensive European imports threaten the region's building boom.

Khalil Sholy, the president of Qatar's United Development Company, said that a year ago when he advertised for a mechanical engineer he would field more than 50 calls from qualified candidates around the world. Today, he is lucky to find one: Now you receive nothing. Things have changed, said Mr Sholy, whose company is constructing the Pearl Qatar, a 400-hectare man-made island, the gas-rich Gulf state's first international real estate venture. Human resources are becoming scarce. Supplies are becoming scarce. De-pegging would help a great deal, he said.

Can someone explain why some currencies are pegged to others? It doesn’t seem natural that a sovereign nation’s currency moves according to another nation’s economic forces. They should all float, right?

Pegging one’s currency to another country’s currency that is widely accepted and reasonably stable is like riding a strong horse that goes where he wants, the pegger has to go along regardless of the direction. Letting one’s currency float is like running a marathon, where one’s currency is depends on where it is in the pack. Being ahead or behind is measured against the position of everyone else.
Letting a currency float is more a default position since if all else fails a currency will have to be floated. Desirable? Depends.

5
posted on 03/17/2008 11:36:32 AM PDT
by count-your-change
(you don't have to be brilliant, not being stupid is enough.)

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